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ACCA

Paper F9
Financial Management

Revision Mock Examination


December 2016
Answer Guide

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Section A

Marking scheme: 2 marks each

1. A
The amount received is: $500,000/$15570 = 321,130

2. A

3. B
Using CAPM, the expected return for the equity shareholders is: 3% + [08 (9% 3%)]
= 78%
The predicted market value of a share is:

P0 = D1/K0
= 40p
------
0078
= 5128 pence

4. C

5. C
Year Cash inflow Discount rate 8% Present value
1 10 093 930
2 110 086 9460
10390

6. C
7. C

80 = X + 12 (7 X)
X = 20
Y = 20 + 18 (70 20)
Y = 110

8. B

The total annual cost is [(25,000/500) x 10] + [(500/2) x 2] + 100,000 = 101,000

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9. C
Project Investment Present value of Profitability Ranking
outlay net cash inflows index
$m $m
J 40 48 12 3
B 45 64 14 1
T 60 66 11 4
N 70 92 13 2

10. D

Under the weak form, new information is not anticipated and share prices change over
time in a random manner.

11. C

The capital structure following the rights issue will be

$000
$050 Ordinary shares 5,000
Share premium 1,400
Retained profits 5,000
11,400

After-tax earnings = 10% x 11,400 = 1,140


Earnings per share = 1,140/10,000 = 114 cents

12. D

Answer D is correct. Retained earnings are not a free source of finance as investors will
expect a return in line with that required by the equity shares of the company. Invoice
discounting does not involve the administration of debtors; it is simply a form of finance.
A bank overdraft is repayable on demand.

13. D

Year 0 1 2 3
Gamma
Cash flows (200) 120 60 80
Discount rate (10%) 10 0909 0826 0751
(200) 10908 4956 6008

NPV 18.72
Year 0 1 2 3
Cash flows (200) 20 60 80
Discount rate (16%) 10 0862 0743 0641
(200) 10344 4458 5128

NPV = (0.7)
So IRR is approximately = 16% as IRR is the rate that makes the NPV zero

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14. A

$
Original share (4 x $1000) 4000
Rights share (1 x $1000 x 080) 8.00
5 shares 48.00
TERP = 48/5 = $9.6
Value per original share = 10 9.6 = $0.4

15. B

The weighted average cost of capital is:

Capital Weight Cost Weighted


cost
Ordinary shares 040 15 60
Loan capital 060 9 54
11.4%

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Section B

16. B

Total Value = Noncurrent assets + current assets current liabilities long term
debt preference share capital
$602m + $750m - $305m - $180m - $105m = $762m
Total Shares = $200m / $0.50 = 400m
Per Share = $762m / 400m = $1.91

17. C

Total Value = $60m x 1.03 / (0.11 0.03) = $1,030m

18. C

Total Value = Earnings (PAT) x P/E Ratio


$216m x 8 = $1728m
Total Shares = $200m / $0.50 = 400m
Per Share = $1728m / 400m = $4.32

19. D

Total Value = $216m x 1.02 / (0.12 0.02) = $2,203m

20. A

21. A

EOQ = (2 x 50 x 8,000)/80 = 100 units

$
Annual purchases (8,000 x $60) 480,000
Annual ordering costs [(8,000/100) x $50] 4,000
Annual holding costs [(100/2) x $80] 4,000
488,000

22. D

$
Annual purchases [8,000 x ($60 x 96%)] 460,800
Annual ordering costs [(8,000/400) x $50] 1,000
Annual holding costs [(400/2) x $80] 16,000
477,800

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23. C

$
Annual purchases [8,000 x ($60 x 25%)] 12,000

24. B

25. B

26. D

Exports to: Imports from:


Company 1 154m
Company 2 89m
Company 3 75m

Total 154m 164m

Net exposure = 164m in payments 154m receipts =10


million payment.

27. A

The company will BUY $ at the low rate!

$850,000 / 2.0325 = 418,204

28. D

The company borrow in the UK and convert at spot rate.

$850,000 / 2.0145 = 421,941

421,941 x 1.027 = 433,333

29. C

The company will deposit $ today earning interest in USA at 4.2% per annum.

Required deposit - $850,000 / 1.021 = $832,517 (2.1% for six months)


The required $s will be obtained at the spot rate

$832,517 / 2.0145 = 413,262


These will be borrowed at a cost of 5.4% per annum (2.7% for six months)

413,262 x 1.027 = 424,421

30. B

The borrowing rates would be used and pro rata for the six months

Predicted spot rate = current rate x (1 + I in counter) / (1 + I in base)

2.0145 x (1.034 / 1.021) = 2.0401

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Question 31

Tutorial help and key points

NPV should be calculated as the present value of future relevant cash


flows (discounted using the appropriate cost of capital) less the initial
investment.

The $2,500,000 research cost is sunk as it has already been incurred and
as such is irrelevant to cash flow. It should be ignored.

Selling price, variable cost and fixed costs are all in current prices and
should be adjusted by their respective inflation rates from year one
onwards.

Tax is payable one year in arrears. Capital allowances are on reducing


balance basis.

Working capital should be included in year zero, subject to inflation with


total recovered in year four.

Comment on the financial acceptability of the project.

Explain at least 3 advantages of IRR.

Explain at least 3 disadvantages of IRR.

Ensure you adjust for the post tax cost of debt

Maintenance is relevant as it is only incurred if machine purchased

Marking scheme

NPV
Sales 1
Variable cost 1
Fixed costs 1
Tax on operating profit 2
Tax saved on capital allowances 3
Residual value 1
Working capital 1
Net present value 1
Comment on the acceptability of the project 1
Max 10 marks

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Advantages of IRR 2
Advantages of IRR 2
Max 4 marks
Post-tax cost of debt 11
Maintenance 1
Tax Saved 1
PV Purchase 1
PV Lease 1
Comment
1

Max 6 marks

Net present value

Years 0 1 2 3 4 5
$000 $000 $000 $000 $000 $000
Sales 42,000 169,820 231,500 36,460
Variable cost (18,720) (75,740) (143,375) (23,860)
Fixed costs (10,500) (11,025) (11,576) (12,155)
12,780 83,055 76,549 445
Tax 30% (3,834) (24,917) (22,965) (134)
Tax savings on capital allows 9,000 6,750 5,063 12,188
Equipment cost (120,000)
Resale value 10,000
Working capital (20,000) (600) (618) (637) 21,855
Net cash flows (140,000) 12,180 87,603 57,745 14,398 12,054
DF (11%) 1 0.901 0.812 0.731 0.659 0.593
Present values (140,000) 10,974 71,134 42,212 9,488 7,148

Net present value $956

Since the net present value is positive the project is financially acceptable.

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Workings

Sales

Years 1 2 3 4
$000 $000 $000 $000

Selling price 2,000 2,200 1,600 1,500


Inflation 1.05 1
1.05 2
1.05 3
1.054
Inflated selling price 2,100 2,426 1,852 1,823
Units (000) 20 70 125 20
Sales ($000) 42,000 169,820 231,500 36,460

Variable cost

Years 1 2 3 4
$000 $000 $000 $000
Variable cost per unit 900 1,000 1,020 1,020
Inflation 1.04 1
1.04 2
1.04 3
1.044
936 1,082 1,147 1,193
Units (000) 20 70 125 20
Total variable cost ($000) 18,720 75,740 143,375 23,860

Fixed costs

Years 1 2 3 4
$000 $000 $000 $000

Fixed costs ($000) 10,000 10,000 10,000 10,000


Inflation 1.051 1.052 1.053 1.054
Inflated fixed cost 10,500 11,025 11,576 12,155

Tax savings on capital allowances

Year Tax saved


$000

1 120,000 x 0.25 x 0.3 9,000


2 0.75 x 9000 6750
3 0.75 x 6750 5063
4 Difference 12,187
(120,000 - 10,000) x 30% 33,000

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Working capital

Years 0 1 2 3 4
$000 $000 $000 $000
Total working capital (1.03) 20,000 20,600 21,218 21,855
Increase in working capital 20,000 600 618 637 21,855
cash flows

Advantages:

Like the NPV method, IRR recognises the time value of money.

It is based on cash flows, not accounting profits which can easily be manipulated.

More easily understood than NPV by non-accountant being a percentage return on


investment

For accept/ reject decisions on individual projects, the IRR method will reach the
same decision as the NPV method

Disadvantages:

Does not indicate the size of the investment, thus the risk involve in the investment.

Assumes that earnings throughout the period of the investment are re-invested at
the same rate of return.

It can give conflicting signals with mutually exclusive project.

If a project has irregular cash flows there are more than one IRR for that project
(multiple IRRs).

Is confused with accounting rate of return.

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(c)

The discount factor is the post tax cost of debt thus 7.14% x (1 - 0.30) =5%

Present value of acquiring the machine (including the maintenance)

Years 0 1 2 3 4 5
$000 $000 $000 $000 $000 $000
Maintenance (3,000) (3,000) (3,000) (3,000)
Tax Saved 900 900 900 900
Tax saved Cap All 9,000 6,750 5,063 12,188
Equipment cost (120,000)
Resale Value 10,000
Net cash flows (120,000) (3,000) 6,900 4,650 12,963 13,088
DF (5%) 1 0.952 0.907 0.864 0.823 0.784
Present values (120,000) (2,856) 6,258 4,018 10,669 10,261

Present value
($91,650)

Present value of leasing the machine

Years 0 1 2 3 4 5
$000 $000 $000 $000 $000 $000
Maintenance (35,000) (35,000) (35,000) (35,000)
Tax Saved 10,500 10,500 10,500 10,500
Net cash flows (35,000) (35,000) (24,500) (24,500) 10,500 10,500
DF (5%) 1 0.952 0.907 0.864 0.823 0.784
Present values (35,000) (33,320) (22,222) (21,168) 8,642 8,232

Present value
($94,836)

PEP should purchase the machine as it incurs a lower cost

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Question 32

Tutorial help and key points

Calculate the cost of equity using the capital assets pricing model. This
requires the use of the risk free rate, equity beta and the average
market return.

Calculate the cost of equity using the dividend valuation model. This
requires the use of dividend, market price and dividend growth rate.

Comment on why the two methods give different answers. This is


mainly due to the different assumptions made by each method.

Calculate the cost of debt as the internal rate of return as the debt is a
redeemable traded debt.

Calculate the cost of the bank loan as the net interest on the bank loan.

Calculate the market values of equity, bank loan and the redeemable
debt.

Calculate the WACC as the weighted average of the cost of equity, bank
loan and the redeemable debt using their respective market values for
the weighting.

Explain the meaning of systematic risk

Explain the meaning of unsystematic risk

Explain the main difference between them

Marking scheme

Marks
(a)
Cost of equity using CAPM 2
Cost of equity using DVM
Dividend growth rate 1
Market price if equity 1
Cost of equity 1
Comment 3
Max 8

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(b)
Cost of bank loan 1
Cost of loan notes:
Net interest 1
First NPV
Second NPV
Internal rate of return = cost of debt 1
Market values of equity
Market value loan notes
WACC 1
Max 6
(c)
Explanation of systematic risk 2
Explanation of unsystematic risk 2
Main difference 2
Max 6

Cost of equity (CAPM) = 5% + 075 x (10% 5%) = 875%

Cost of equity (DVM)

Growth rate = 100% x ($018/$014)1/5 1 = 52%

Market price per share = 11 x ($018 x 100%/40%) = $495


Cost of equity = [($018 x 1052 / $495) + 0052] x 100% = 903%

The answers are different because of the assumptions made in calculating them. The DVM
method is an implicit method in that it assumes that the future growth rate of dividends
and the share price are accurate. The CAPM method is an explicit method, in that it
assesses the cost of equity based on the systematic risk of the investment, which is given
by the beta. The systematic risk cannot be diversified away and reflects the business and
financial risk of the company.

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Cost of bank loan = 7% x (1 025) = 525%

Cost of loan notes

Year Cashflow 6% DF PV/NPV 5% DF PV/NPV


0 (103) 1 (103) 1 (103)
15 6 412 2527 4329 2597
5 100 0747 747 0784 784
(303) 137

Cost of loan notes = 5% + 137/44 % = 531%


Market value of equity = $495 x 200,000,000 shares = $990,000,000
Market value of loan notes = 103/100 x $150,000,000 = $154,500,000
Market value of bank loan = $120,000,000
Total market value = $1,264,500,000

WACC = (875% x 990) + (525% x 120) + (531% x 1545)/1,2645 = 8%

Systematic risk or market risk is the risk that cannot be reduced or eliminated as a result
of a well-diversified portfolio.

The systematic risk is measured by the beta factor and thus measures the sensitivity of a
security to changes in the returns on the market as whole. It simply measures the
relationship between the market return and the individual security return.

Unsystematic risk or unique risk is a risk which can be reduced or eliminated as a result
of a well-diversified portfolio. Unsystematic risk relates to individual or specific companies
rather than to the financial system as a whole.

CAPM distinguishes between systematic and unsystematic risk and indicates that unique
risk can be cancelled out by diversification, thus, in a well-balanced portfolio an investors
gains and losses from the unique risk of individual shares will tend to cancel each other
out. The distinction between these two risks can be shown as follow

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